An economic term for the wrongs of the world

One Friday, a long time ago, I was fortunate enough to travel in the jump seat on the flight deck of a Boeing 737 from Brussels to London. It was a bright early Summer morning, and all through the flight I had a superb forward view through the cockpit windows – not least thanks to several gyrations in the stack over London (even in those days, the airspace was congested). But aside from the sights, one other thing has stuck in my memory.

Before we set off, I had seen the pilots go through a checklist, meticulously verifying that everything of vital importance in the plane was working as required. This is a critical procedure to ensure the safe operation of the aircraft, which is systematically executed before every single flight, without exception.

Aligned interests

One reason why the pilots adhere to this requirement so consistently is undoubtedly their training. But another one is that, quite literally, their life, along with that of their crew and passengers, may depend on it. They have ‘skin in the game’ – a phrase with uncertain origins, but popular in business and finance, certainly since Nassim Taleb used it as the title of his eponymous book.

It is an evocative way to express that a decision-maker will suffer the consequences of a poor decision. As far as the pilots who flew me that day, along with every pilot of every flight are concerned, there is no doubt that they have a direct motivation to ensure that their aircraft is safe.

We need to be careful, though, not to attach too much importance to this one facet of a relationship (as here between pilots and passengers, who engage them implicitly to transport them safely). On the one hand, we must not assume that someone who has skin in the game necessarily has objectives that align with our own. The tragedy of Germanwings 9525 in March 2015, when the co-pilot deliberately flew the plane en route from Barcelona to Düsseldorf into a mountain, killing all 150 people on board serves as a grim reminder. On the other hand, skin in the game is not the same as skill in the game, as a New Yorker cartoon illustrates.

But by and large, if someone you rely on has skin in your game, that is a good heuristic indicating that they are more likely to act in your interest. For example, there appears to be evidence that funds run by managers who themselves invest in the funds they manage, perform better overall. In any case, it is not hard to see how those who simply charge an annual percentage of the value of a client’s holding, irrespective of how it performed, have much less of an incentive to ensure the fund grows: if their client makes a loss, they gain less but they still gain.

Economics is often a good lens through which observe human behaviour, and not surprisingly it has a term for this kind of situation. If A conducts a transaction with B, and the choices this involves have a consequence for a third party C which is not involved in this transaction, we have a so-called externality. When a plane is late in taking off because of a problem on the ground, air traffic control may grant the pilot (A) the possibility to fly faster than normal to reduce the delay. However, B has a contract with the airline (B) which incorporates targets on fuel usage to keep running costs of the airline low. So the pilot declines the possibility and the plane arrives late – thus inconveniencing the passenger (C) who had no influence over the decision. The pilot (and the airline) may have skin in the passenger’s game where the safety of the plane is concerned, but they do not have much skin in other aspects of the passenger’s concerns. They prioritize their fuel cost over the convenience of the passenger, who suffers a negative externality.

Shameful externalities

Such externalities are quite common, and not only in conventional economic transactions. Environmental pollution is a prominent example, but there are many more, including roadworks and traffic congestion, smoking in the presence of others and smoking bans, and mowing the lawn or practising the violin. In all cases the decisions made by one party are imposing a burden on another party that is not involved.

Once you start looking for externalities, you see them everywhere. Last weekend I read a heart-breaking blogpost by Andrew Morrish, a former head teacher who currently runs a trust comprising multiple publicly funded independent schools. It is worth reading it in its entirety but, writing with a lump in my throat, I will summarize it here:

Daisy is an 8-year old girl. It is her last day at school before the half term break. She has been in foster care with local foster parents for two years, but this afternoon, after school, she will be taken by a social worker, to a town 30 miles away. She will be taken away from the school with the teachers and support staff she got to know, and from the fragile chain of friends she has built up over the last two years. She will be all alone again, having to build a new chain of friends. And she does not know. She does not know that today is the last day she will see her friends, the teachers, and the staff, that she will not see them again once they leave as she stays on, waiting for the social worker to pick her up. She cannot say goodbye, because the move must remain confidential until she is taken away. She is 8 years old.

This is happening to her because others, far away and long ago, have made certain choices. Daisy was not involved (how could she have been?), yet she will definitely suffer. When you suffer a negative externality because your neighbour mows his lawn while you want to enjoy the peace of your back garden, you have a voice. You can reason with him, negotiate with him, yell at him, even. You can stand up for yourself and seek redress. Daisy is alone with her negative externality.

There is nobody with skin in her game. Some procedure determines that this is what must happen to her now, and to countless other children at some point. The social worker is only following instructions, powerless, numb perhaps from the many times she has been confronted with similar distressing situations. All she can do is try her best to comfort Daisy.

These are the shameful externalities that are unworthy of a civilized society. What happens to Daisy is the consequence of trade-offs made by undoubtedly well-meaning experts, has been approved by undoubtedly well-meaning politicians, and is being executed by undoubtedly well-meaning social workers. And still, Daisy is abruptly taken away to a strange place where she will know nobody.

Being well-meaning is not enough. We all sometimes make trade-offs that may directly or indirectly affect other people down, sometimes way down, the line. It is easy to be well-meaning and think about the consequences of our choices to these people in the abstract. But they are real people, just like Daisy. We can choose to make different trade-offs, trade-offs that really take those others, whether they be close or distant in time and space, into account.